Abstract

This paper examines the predictive power of shifts in monetary policy, as measured by changes in the real federal funds rate, for output, inflation, and survey expectations of these variables. We find that policy shifts have larger effects on actual output than on expected output; thus, policy predicts errors in output expectations, a violation of rational expectations. Policy shifts do not predict errors in inflation expectations. We explain these results with a model in which agents systematically underestimate the effects of policy on aggregate demand. This model helps to explain the real effects of policy.

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Additional Information

ISSN
1538-4616
Print ISSN
0022-2879
Pages
pp. 473-484
Launched on MUSE
2003-07-17
Open Access
No
Archive Status
Archived 2007
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